The conservative leader announced a 3-point hike in the main rate of Value Added Tax on goods and services to 21 percent and cuts in unemployment benefits and civil service pay and perks in a speech interrupted by jeers and boos from the opposition.

“These measures are not pleasant, but they are necessary. Our public spending exceeds our income by tens of billions of euros,” he told parliament.

Perhaps someone who knows Europe better than me can fill me in on the ECB inflation target. One would think they’d target inflation net of VAT (if they must target inflation at all.) Is that what they do? If they targeted prices including VAT, then obviously the current wave of austerity would force the ECB to deflate the net price of goods as VAT increased, the prices actually received by firms. And that would boost unemployment even higher.

“We are living in a crucial moment that will determine the future of our families, our youth, our social welfare and all our hopes,” Rajoy said. “That is the reality. We have to get out of this mess and we have to do it as soon as possible.”

Analysts criticized the lack of structural economic reforms but conceded that the government had little room for maneuver.

The obvious solution is for the ECB to ease monetary policy. The next option is devaluation. And then . . . actually there are no other good options for “getting out of this mess as soon as possible.”.

In 2009, Malcolm Gladwell wrote a piece for the magazine about a team of skinny, ill-trained girl basketball players who nonetheless advanced to the California state championship, partly by upending notions of how defense should be played. Underdogs, Gladwell wrote, win far more often than you might think; and they do so particularly when they replace ability with effort and figure out new ways to play the game.

Like everything else I read, this reminded me of me. I was a skinny, ill-trained basketball player as a teenager. And now I’m a blogger who makes up for lack of ability with effort and figuring out new ways to play the demand stimulus game.

Unfortunately my lack of skills extends to computers. Yesterday I switched to an iMac and I have no idea how to do even the simplest tasks, such as closing out windows. Last night I spent an hour trying to figure out how to “scroll.” So my productivity will drop sharply over the next month. I won’t be able to answer the huge backlog of comments, but I’ll read them, and do new posts if important issues get raised.

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Consider that the increase in the VAT is localized to Spain, and that the ECB’s target doesn’t consider Spain’s fiscal policies over other Euro members’. But, if your of the opinion that what Spain needs is loose monetary policy, then this increase in the VAT is the least of it.

Scott, it’s even worse than you think. This is from last week’s ECB statement:

“Taking into account today’s decisions, risks to the outlook for price developments continue to be broadly balanced over the medium term. The main downside risks relate to the impact of weaker than expected growth in the euro area. Upside risks pertain to further increases in indirect taxes, owing to the need for fiscal consolidation, and higher than expected energy prices over the medium term.”

Needless to say, I’m completely baffled by this. Why would you run a tighter policy than otherwise would be the case in response to an increase in indirect taxes? And what makes the ECB think that the risk to energy prices tilted to the upside? Are they in the business of trading Brent futures now?

The whole point of inflation targeting was that it was supposed to be the best way to stabilize aggregate demand. But the ECB clearly thinks that the risks to AD are all to the downside. Their upside risk to inflation comes from entirely supply shocks. It’s incredible.

One would think they’d target inflation net of VAT (if they must target inflation at all.) Is that what they do? If they targeted prices including VAT, then obviously the current wave of austerity would force the ECB to deflate the net price of goods as VAT increased

I admire your optimism. Not sure what the aggregate euro-area VAT effect has been, though we know from de Rugy’s graph that “austerity” has basically meant higher taxes.

“A fascinating FRBNY study shows nearly all of the S&P 500’s return since 1994 has been earned in the 24 hours prior to scheduled FOMC announcements (which occur just 8 times per year!). Going further, excluding the 3-day window before and after scheduled FOMC announcements yields a flat S&P over the last 28 years.

Rajoy is going to crush Spain with this. Many large transactions were already off the books with a VAT at 16. 18 did not help. 21? Expect rampant fraud.

A VAT just does not work in countries that are as attached to cash as Spain. It will be dodged, revenues will keep falling, the austerity will be contractionary, and eventually Spain will exit the Euro, killing it in the process.

I don’t know exactly what the ECB targets, but I think it may be, and *ought* to be, the same as what the Bank of Canada does.

There is nothing explicit in the BoC’s inflation target that mentions indirect taxes. But when the GST (our VAT) was introduced, the BoC did say it would “look through” one-time increases in the CPI due to the GST, but would stamp out any “second round effects”. And the BoC does describe core inflation, which adjusts for the “effects” of indirect tax changes, as its “operational guide”.

(You could say that when “inflation targeting” is interpreted as targeting inflation net of indirect taxes, the Bank of Canada is already implicitly acknowledging that NGDP targeters have a point when it comes to SRAS shocks, at least when it comes to one particular case of SRAS shocks.)

One would think they’d target inflation net of VAT (if they must target inflation at all.) Is that what they do?

i have been told and led to the ecb website where it says they target the harmonized price index HICP, which includes VAT and imports. I believe that was also the essence of Lars Christensen “failed monetary policy – one graph version” of ECB policy a while back.

and yes they consider this a feature not a bug from what i’ve gathered on.

oh the agony, oh the shame.

for example, from a paper on the ecb website:
“The prices, which should be used in the HICP, are consumer prices (or final demand prices) rather than producer prices. Thus harmonized prices should include commodity and value added taxes in principle.”

I went from an old Mac to a new Acer last fall, and had just the opposite problem. When I took classes a couple of years ago and couldn’t use my Mac for the computer portions, it took me several weeks to catch up with everyone! Hopefully it won’t take long to figure out your new iMac.

I linked to the Stevenson-Wolfers piece in the comments on an earlier post too, it’s crucial I think to get buy-in for market monetarist ideas from economists whose core focus isn’t just macro. Doesn’t hurt that Stevenson is Chief Economist at the US Department of Labor.

As “ždwb” has pointed out, we had this discusssion already.
The only target the ECB has, is price stability, as defined in:http://www.ecb.int/mopo/strategy/pricestab/html/index.en.html
The HICP measures what it should do: final consumer prices (without artificial OOH , rent equivalent, stuff like the US CPI, BUT including food, energy, and VAT)

Now take a look athttp://www.typicallyspanish.com/news/publish/article_23254.shtml
What amount of consumer purchases really gets hit by the VAT increases, especially for the “žpoor”? 25% – 40 % ? for about 60 Mio Spaniards out of ca 300 Mio Euroland members ?
And since in the most EU countries the VAT is included in the prices displayed, the final consumer prices are sticky, in contrast to the US habits.

30 % * 60 / 300 * 3 % = 0.2% one time Euroland VAT inflation, smeared out over 1-2 years, max.
This is a complete non-issue, well within the noise level. We have been through this so many times, like German VAT hikes, this is boring. There is not even a need to “see through” this.

The Eurozone GDP deflator is up 1.1% y/y and less than 1% annualized over the last quarter. More striking, it is nearly 3% below its pre-crisis trend path. NGDP in the EZ is 11% below its pre-crisis trend level. And the ECB has undershot its “reference rate” for broad money of 4.5% p.a. for 37 straight months. And yet all we have gotten from “Super Mario” over the last month is an incredibly dilatory and reluctant 25 bps rate cut, the absolute least the ECB could do while still saying it did “something.” Fail.

you know very well, that “GDP deflator” and “broad money” increases are only relevant in your parallel universe and not at all in the real World of Europe, governed by Ordnungspolitk, from now on also in the South.

The ECB does what it is tasked to do, as described in the Maastricht treaty, and not what American banksters and academic non-practioners are demanding.

Scott,
“If they targeted prices including VAT, then obviously the current wave of austerity would force the ECB to deflate the net price of goods as VAT increased, the prices actually received by firms. And that would boost unemployment even higher.”

The Euroausterity torture machine is like a head vice with the ECB on one side, and the fiscal authorities on the other, each frantically tightening as the other’s actions make it harder and harder for each of them to hit their own respective targets of inflation and fiscal responsibility.

Prices are already going up because of VAT and you want to increase inflation even more?? You evil person!

That’s a joke; but there are about 1000 people in the euro zone who would read it as a joke. Everyone else actually thinks that way. Mostly, the ECB and the euro get criticized by public opinion for allowing inflation to be so high.

As dwb points out above. If you instead of looking at HICP inflation which is the inflation measure the ECB targets looks at the GDP deflator you will see the the ECB massively has undershot the “close to 2%” inflation target. I illustrated that sometime ago in the post dwb refers to -http://marketmonetarist.com/2012/05/14/failed-monetary-policy-the-one-graph-version/

The reason (at least the official reason) why the ECB is so afraid of correcting for supply shocks and VAT increases is the perceived risk of “second round effects” to inflation. That obviously is nuts – as there is no inflationary risks at all in the European economies. In fact you would hope that there was “second round effects” as this would make monetary policy more potent.

Maybe there is something to this “you can’t have totally different cultures in a single currency area” idea after all. I wouldn’t want to be in a common currency area with people who were so….words fail me.

Gregor, Nick, and Scott:
The mind boggling stupidity of the VSP’s NEVER ceases to amaze me.

Major Freedom:

A hint of sanity:

“Deflation targeting is just as destructive as inflation targeting. Both are actions that operate outside the market forces of profit and loss.”

“The obvious solution is for the ECB to ease monetary policy. The next option is devaluation.

All hail the money printing God!

Rewarding bad behavior with inflation ought to finally teach those Spaniards a lesson. Inflation will give a huge incentive for them to correct their errors. Oh wait…

But.. then a return to sociopathy:

“But it could be argued that deflation targeting can solve past malinvestments quicker.”

“The obvious solution is for the ECB to ease monetary policy. The next option is devaluation.

All hail the money printing God!

Rewarding bad behavior with inflation ought to finally teach those Spaniards a lesson. Inflation will give a huge incentive for them to correct their errors. Oh wait…”

Yes wait.. wait and see Iceland, Argentina, after 2001 and the United States, after it left the gold standard in the 1930’s even if you hold by the nonsense theory of ABCT, you have to hold that the crash isn’t forgotten THAT quickly. Also It IS possible to pursue austerity in one regard, while by generous with another, you should see that Im talking about Iceland

Whoever set up your iMac did you a disservice by dismissing the dialog box that teaches you how to scroll.

If you’re having trouble with the basics, take a look at Apple’s Mac 101 tutorial””I’ve set it as the website on this post. And don’t be afraid to use Help””Apple’s help books are written in simple language that even an economics professor can understand.

The markets also tanked today after the Fed minutes. They say they are open to buying more bonds if things get even worse. Kind of like when the police promise to help a woman with her stalker once he has his fingers around her neck

The markets also tanked today after the Fed minutes. They say they are open to buying more bonds if things get even worse. Kind of like when the police promise to help a woman with her stalker once he has his fingers around her neck

Yes wait.. wait and see Iceland, Argentina, after 2001 and the United States, after it left the gold standard in the 1930″²s even if you hold by the nonsense theory of ABCT, you have to hold that the crash isn’t forgotten THAT quickly. Also It IS possible to pursue austerity in one regard, while by generous with another, you should see that Im talking about Iceland

The markets also tanked today after the Fed minutes. They say they are open to buying more bonds if things get even worse. Kind of like when the police promise to help a woman with her stalker once he has his fingers around her neck

It’s telling how you view not devaluing poor people’s income as allowing rape.

Does it matter to Spain if the VAT is included in price level calculation? Not much, since Spain’s VAT increase won’t affect prices elsewhere in the EMU. 25% unemployment is the hard way to deflate your price levels. Politically, it can’t be done. Euro breakup is inevitable.

Regarding your change to Apple computer, reconsider what and why you’re doing it. My colleagues who have gone that route still regret it a year later. They end up running Windows anyway, except they still miss the better keyboard (for example, having both delete and backspace as stand alone keys). Unless you write serious developer code, or do mass amounts of audio / image processing, learning the Apple OS is an intellectual pursuit with little benefit. It will just take up a lot of your time initially, and then continue to quietly frustrate as you remember things you could do as well or better in Windows. Pointless. Stop now, and simply admit you’ve goofed. Instead get a new Windows machine and sell your Mac to your kids or to others who don’t yet know Windows.

BTW, you write a great blog, and your energy and dedication are an inspiration.

There is just a phobia, a hysteria, a perverted milieu in central banks regarding inflation.

Remember, central banks are kin to public agencies—there are no market forces to wipe out the antique, bad or stupid enterprises.

Public agencies develop hoary missions and goals, encrusting over the decades.

In the USA, federal agencies fight hunger in a nation of fatties, and support farmers 80 years after the Dust Bowl. We have a Cold War military now on steroids due to a single terrorist attack.

And we have a centric bank that has deified low inflation rates, and genuflects to nominal price stability (if that can even be measured). (It doesn’t help that we have a right-wing that conflates tight money with federal austerity, somehow thinking economic asphyxiation is a cure for agency obesity).

The Fed has become a perversion, and there are no market forces to correct it.

“We show that since 1994, more than 80 percent of the equity premium on U.S. stocks has been earned over the twenty-four hours preceding scheduled Federal Open Market Committee (FOMC) announcements (which occur only eight times a year)””a phenomenon we call the pre-FOMC announcement “drift.””

“Further, we don’t find analogous drifts ahead of other macroeconomic news releases, such as the employment report, GDP and initial claims, among many others. The effect is therefore restricted to FOMC, rather than other macroeconomic, announcements.”

Jonathan, Not just Spain, I’ve read stories of higher VAT in other countries as well.

Gregor, Wow. It’s even worse than I thought–they are intentionally trying to offset the inflation effects of higher VAT. Is the ECB composed of morons? Or do the feel that’s the mandate they’ve been given?

Doug, You said;

“The point of inflation targeting is that it is supposed to be the best way to stabalise the value of the currency.”

No it’s not, otherwise they’d aim for zero percent inflation.

Saturos, People should have told me before I switched.

Liberal Roman, Interesting–of course those anomolies almost never hold up after they’ve been published.

Nick, Interesting, but Gregor suggests they are targeting the price level including VAT.

dwb, That’s even worse than I thought. They really are morons if they think the price including tax should be targeted.

becky, I went from a $280 Acer to a $2500 iMac.

Ed, Thanks for that quote–is there a link?

Saturos, Marcus and Johnleemk, Thanks for the links.

Genauer, Are you seriously defending them? That policy is completely insane. And what about the other countries raising their VAT? This was a big issue in Britain last year.

Thank you for confirming what I strongly suspected: the ECB does include VAT in the inflation it targets.
It looks to met that it does not take a confirmed economist to understand that it doesn’t make any sense.

I’m still impressed that your little Acer was strong enough to run this blog. I bought a semi-portable Acer back in the nineties before anyone knew what Acer or Internet were – fifteen pounds of mostly word processing capacity! My mistake was getting frustrated at Windows after being used to the simpler (for me) processing with DOS, so when I finally came back to using computers four years ago, it was with the Mac.

Hear is an example were the in-specificity of op-eds bowls me other. I’m not an expert on ECB, so if Lars say HICP includes VAT, OKAY, but I’ve read many anti EU-austerity essays. The only place I’ve seen this particularized criticism is in Lar’s blog.

That tells me something about the Austerity debate: it’s really a rat not for sound economics but for interest groups who are fighting liberalization of the EU economies.

Spain explained its VAT increase as follows…
– EU policy is to favor consumption taxes over taxes on labor and income and this VAT increase aligns Spanish policy with known best practices in the EU.
– Meanwhile this reform is paired with cutting back ‘transfer payments’ principally in the form of reducing unemployment compensation

In short, these appear to be ‘just so policies’ in-line with the consensus viewpoint of AD stabilization by the CB, reducing investment drag, and AS reforms. The CB part is failing to come through.

The critical essays on the ECB though seem to be pure claptrap–no more substance to the argument than ‘things are bad in some countries, the ECB should do more; the currency-zone is bad, destroy the Euro’. As if that sort of rhetoric would persuade the ECB.

Just imagine if people started saying… this is nothing wrong with the Euro. One policy can work across these countries, it has in the past, but there are some technical limitations with HICP and that’s leading to disinflation and underperformance.

Suddenly everyone would be talking the same language, and we might get somewhere.

It looks like the ECB’s recent decision to reduce the deposit rate to 0.25% is causing some big expansionary effects. http://goo.gl/RDF5s

As explained in the linked article, overnight deposits with the ECB cratered 484 billion euros. So where did that money go? I think the answer is pretty clear that it went into buying safe haven sovereign bonds all over the world, which explains why those bond yields have dropped like a rock. A good example was yesterdays 10 Yr US Treasury auction.

Isn’t this roughly the same as massive QE? Dropping 484 billion euros into the worlds bond markets in the space of a couple of days seems extremely aggressive compared to buying $600 billion of US Treasuries over the space of six months ala QE2.

“Although economists were about evenly divided on whether the Fed would embark on QE3, just 13 said the central bank should start a new bond-buying program. Many said the effect of more purchases would be limited.

“An honest accounting of the economic situation inevitably leads to the conclusion that yet another round of market manipulation/liquidity injection would do little or nothing besides perhaps artificially inflating some asset prices,” said Stephen Stanley of Pierpont Securities in a recent note to clients.”

Bingo. One nominal price is just as arbitrary as any other nominal price. Any nominal price is “artificial”. Any monetary authority is constantly issuing and retiring the currency, whether it’s buying and selling commodities, foreign currency, government bonds, etc. If it issued or retired a different amount, nominal prices would be different. Nominal prices are also different in Japan than the US. So what?

If you had a gold standard at $20 per ounce you’d have different nominal prices than a silver standard at $1 per ounce. And an NGDP standard of 1/16 Trillionth GDP per dollar would have some other set of nominal prices. And one based on some combination of inflation and unemployment would have yet another. So what?

How can anyone say one of those regimes is “real” and the others are “artificial”? Shouldn’t we just admit currency is a man made legal abstraction and therefore we should use whatever standard leads to the broadest general prosperity?

[…] The ECB have announced that if you raise taxes, and in doing so raise prices, they will respond with tighter monetary policy, just as people like Scott have feared. […]

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.